In our discussion on Sunday’s poll about whether government policy should be steering people into homebuying, I had an interesting idea that I thought was worth sharing with the whole class.

The Problem
There are numerous problems with the methods the government has used and is using to promote homebuying. One-time homebuyer tax credits just shift demand around, getting people to buy a few months or a year before they would have otherwise bought. The mortgage interest deduction is more of an encouragement for people to borrow money than it is to buy a home. Thankfully the tax credits seem to stand little chance of returning, but given the fact that the National Ass. of Realtors is the fourth-largest buyer of politicians in the nation, it seems unlikely that any of the current talk of eliminating the mortgage interest deduction will come to pass.

The Assumptions
Let’s assume for a moment that the government is never going to get out of the business of social engineering when it comes to the housing market. However, let us also assume that it is possible to replace inefficient policies with more efficient ones that achieve the same social engineering goals.

The Proposal
What if instead of just eliminating the mortgage interest deduction, we replaced it with something more fair that could achieve the goal of encouraging home ownership (thus placating the Realtors and their bought-and-paid-for legislators) without also encouraging massive, ever-increasing debt? Here’s my proposal: Replace the mortgage interest deduction with a single flat deduction for owning your primary residence.

My flat deduction would work the same way the dependent exemption works today. One flat amount applies to the whole nation, available to anyone who owns their primary residence. You can only take it on one home at a time, and it doesn’t matter if you have a mortgage or not, you get the deduction as long as you keep your home.

The Benefits
Having a flat homeowner deduction instead of a deduction based on how much mortgage interest one pays would encourage home ownership without promoting excessive debt. This program would reward people for actual home ownership, not just home indebtedness, as they would continue receiving the deduction even after they have paid off their home.

You could also build additional features into this plan to encourage other aspects of responsible home ownership, such as if you have a foreclosure on your record, you’re not eligible for the deduction for at least seven years. This would discourage people from the “buy and bail” strategy that some have been employing to get out of paying the mortgage on a home they overpaid for.

The Objections“But what about the fact that homes are more expensive in San Francisco than they are in Topeka? Shouldn’t buyers in more expensive cities get a larger deduction?” – Why should they? If you choose to live in an expensive city, you know what you’re getting into. It also costs a lot less to raise a child in Topeka than it does in San Francisco, but the Dependent Exemption isn’t any different. Why should the home owner deduction get special treatment?

“The mortgage interest deduction is sacred. Any attempt to eliminate or adjust it will destroy the economy, and possibly the entire universe.” – Hmm, it is rather difficult to argue with such impeccable logic. How about we just give it a shot and see what happens?

The Conclusion
So, that’s my proposal. What do you think? What objections come to your mind? The main reason I can think of that it will never happen is that it is just too practical, not complicated enough, and doesn’t result in enough kickbacks to powerful industries. But maybe I’m just too jaded about politics.

About The Tim

Tim Ellis is the founder of Seattle Bubble. His background in engineering and computer / internet technology, a fondness of data-based analysis of problems, and an addiction to spreadsheets all influence his perspective on the Seattle-area real estate market.

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59 comments:

I agree with you that NAR would lobby against, and ultimately kill, any attempt to get rid of the homebuyer’s tax credit. However, I’m not sure this proposal would fare any better. This would encourage people to spend less money on houses, which means there would be less money for commissions to realtors. NAR would lobby quite heavily against any proposal that means less money for its members.

We do NOT get any child deduction. We do NOT get to deduct preschool expenses. We DO get to pay 33% of our Federal Taxable Income in taxes.

No amount of mortgage interest deduction or flat rate property tax deduction will come anywhere close to recovering our 33% taxation. The mortgage interest deduction has NOT been heavily weighted in any of our household financial calculations.

Hate to bring it up again, but what about the capital gains forgiveness tax break on the sale of a house? Needless to say, capital gains are not as common as during the bubble. :) I haven’t heard whether you can declare a capital loss if you sell a house for less than you bought it for (forgiving short sale mortgage debt is different, and treated as income, right?) and what that does to your taxes.

Too much tax write-off for the top 1% and even 10% household incomes in America, its that simple. Hey, I’m strangling SWE too, agreeing to your proposal….but you made me smile when you said it applies to $0 mortgage home owners too.

A caveat, it equally rewards saving your money and spending your money on a flat table….now what’s wrong with that?

Hi Senator Cantwell- my name’s Gorden Gecko, I’m a lobbyist for the United Auto Manufacturers Of America.. I wanted to talk with you about the need to bolster American auto manufacturers through tax support for car ownership, a solid program that recognizes both the need to support existing American manufacturing facilities and jobs along with responsible credit use. . . . And so it goes.

With annual budget deficits equal to 40% of federal spending we need less government and fewer tax deductions. The best way to design the “perfect deduction” is to eliminate all of them and end the discussion.

Child Deductions Have Changed Per IRS Rules Since It First Began Under Bush

It used to be ya gotta $1000 tax credit per kid, slam dunk.

Then, about 5 years ago there were income limits to reduce and even eliminate the credit, it mitigated my last kid especially. But I was still smiling, the old timers [hey, SWE isn’t that old] in the office didn’t see any tax credits raising their kids, even the Family Friendly Act wasn’t until about 1996 under Clinton and the older Boomers missed that one too.

Good thoughts Tim. However, you may need to pacify another lobby highly connected to the umbilical cord of housing— the folks in the mortgage biz. Many touted the larger the loan the more interest deduction and, during the go-go days, encouraged the larger the leverage (purchase) the “more” money you made during the appreciation phase.

We pay workers enough money to live in America, the WTO wants to compete with us with prison wages [foreign protectionism], so ya just tarriff their products the “difference”….that way, even California could pay $15/hr for peach pickers in the 100 degree desert and they’d have L & I insurance too for climbing dangerous ladders [instead of slave labor]. Yeah, peaches may go up in price a bit….but so will professional wages, as the economy get’s back on its feet.

Same with autos…ya make the manufacturing workers breath acetone and pay them prison wages [foreign protectionism], we tarriff the difference and buy cars from Detroit without tax payer subsidies.

Deductions introduce, indeed force, distortions in the system resulting in inefficiency, misallocation of capital, political favorites and the resultant winners/losers, etc. I just don’t trust the government as God.

You’re talking about the competition between foreign and domestic manufacturers. I’m talking about domestic competition between home builders, auto manufacturers, boat builders, etc. for those ever more rare domestic consumer dollars.

RE:m-s @ 7 – The tax treatment for houses is a substitute for an old system that was rather unworkable. Before you used to be able to roll the gain over from house to house, and then when over a certain age (55, 60, 65–I don’t remember), you could exclude 250k/500k if single/married. The obvious problem with that is that your basis when 65 would have to be calculated all the way back to transactions occurring when you were 25, including any remodel or other improvement transactions.

In addition, until recently (2000 or so), most the gain was largely the result of inflation, so they were only taxing inflation if they taxed houses. That’s probably the largest reason they opened up the exemption.

Finally, you cannot deduct a loss on the sale of your house. Personal gains are taxed, personal losses are not recognized. (Personal means non-business, non-investment).

The child credit is probably what David is referring to. I also am completely phased out… In SoCal, most people who would be considered “middle-class” elsewhere are phased out. Basically, if AGI exceeds a certain amount, you still get the dependent exemption (a miniscule amount when you consider the cost of a child), but you don’t get the child tax credit.

They are both worth about the same for a higher tax bracket, but one phases out while the other doesn’t.

There should be one tax break to relieve indebtedness, and another separate break for partial or whole ownership of equities like land, structures, or equipment which are essentially businesses. They learned in the last century that rewarding indebtedness, especially for homes, keeps many people using pitchforks in their yards instead of in the streets. Taxation is social engineering by definition, it pays the bills of governance. Since somebody has to own land or assume responsibility in order to rent it, that should be rewarded through tax relief. Governments or equally large institutions who own land are already rewarded by pooling their resources and risks at scales individuals can’t match. Encouraging more individual home ownership keeps people occupied in benign activities and stems further institutional encroachment into the private sector. That’s mostly good.

I’m afraid I must play the role of curmudgeon. How about we lobby for the government to abandon reckless social engineering experiments and stay the heck out of the housing market all together? First there’s the issue of fairness. As a renter why should I be forced to subsidize someone else’s home buying dream? Buying a home vs. renting is hardly a moral imperative, as the current economic debacle clearly demonstrates. Second, I believe if there’s any role for government in the real estate market it should be teaching and encouraging rational economic decision making, not manipulating people’s emotions. I acted rationally and responsibly during the boom and resisted the poison fruit, though I admit I almost caved into the mania. If more people had acted rationally during the boom years we wouldn’t be in this mess. Third (and this is a serious question), exactly what benefit does society derive from pushing those people on the home-buying margin over the edge? I’m not sure I buy the argument that owning a house somehow makes this particular demographic more community-minded and socially responsible. Are there any studies that actually support this argument? Lastly, what about the downsides of home ownership, particularly indebtedness and economic immobility? Don’t these downsides at least partially offset the former?

Don’t be so sure the interest deduction won’t go “bye bye”. Remember, it used to be ALL interest was deductible. In 1986 this was scaled back to just mortgages.

Folks, these are just the early innings. The “great” depression lasted 12 years and only ended because the economy was completely retooled for war. People are waking up and realizing debt is the poison. A critical mass is growing. Look what’s happening in Europe — forced austerity — and expect that here at some point. Don’t forget, the US credit rating was downgraded. Lots of shock and awe coming. We’re just getting warmed up.

The only objection I see to this from a social engineering perspective is it may be an additional incentive for seniors to ‘age in place’ in a home/location that is otherwise poorly suited to the elderly.

On the other hand, it might also be a benefit to those on a fixed income that isn’t keeping up with cost of living.

Iâ��m afraid I must play the role of curmudgeon. How about we lobby for the government to abandon reckless social engineering experiments and stay the heck out of the housing market all together? First thereâ��s the issue of fairness. As a renter why should I be forced to subsidize someone elseâ��s home buying dream?

I’m not disagreeing, but there are a number of programs with affect the rental market. Low income housing programs to build facilities, Section 8, etc. The net effect of all that is questionable–it might raise or lower the cost of renting.

Third (and this is a serious question), exactly what benefit does society derive from pushing those people on the home-buying margin over the edge?

I’ve been making a similar argument since 2007. Specifically, those first time buyer programs the state and some cities offered which was typically in the form of a second or third position loan, that loaned the money for the down payment and closing costs, and was sometimes even negative amortization. I wonder what the default rate is on those from that era, and how that’s affecting the state budget now?

About the only system like that which makes sense, IMHO, are some of the land trust programs, where the first time buyer doesn’t actually buy the land, but does get some benefit if the property goes up in value. I’m not sure what happens if it goes down, but I think it’s possible they can sell to another first time buyer without going the short sale route. That would be interesting to find out.

I have been enjoying this website for years – and am finally inspired to post.

IF we are going to allow a housing deduction in the US – I would prefer to see the deduction be for housing in general. Whether one rents, has a mortgage, their home is paid for, or if they are living with in-laws (or outlaws)….they would get a deduction for what they are paying for housing. In reality, this would allow everyone to not pay taxes on the amount of income they earn that goes to their housing expenses. (with rules and limits of course)

The mortgage interest deduction only helps those in debt and especially those in a lot of debt. It does NOTHING for the renter who is usually less affluent. It does NOTHING for the retired who often have their home paid for, and again are less affluent. Why do those in debt get tax breaks? It was their free-will choice to borrow money. It seems like the renter and the retired should be able to get tax breaks for their housing expenses, just as much as those that are able to borrow money.

For example, if my rent is $800 a month, I would not pay taxes on the $800 that I earn to pay for my housing. If my home is paid for, I would get say, $500 deduction, so that I do not pay taxes on the $500 I earn that pays for some of these expenses. If I have a mortgage and I pay $3,000 in interest, I would only get say $1,000 deduction for my housing expense.

I really cannot support the home-mortgage interest deduction. Those who do not qualify, are in effect, subsidizing someone else’s personal expenses. It may have been a good idea when it was first instituted, but I am not confidant that is still a good idea today.

RE:gr8day @ 31 – As a renter, I understand your logic. But the problem is the deduction itself, and your proposal only expands it to those who currently do not have it. Which will cost a whole lot more money.

If you want to even it out among the various constituencies, remove it from those who currently have it, don’t expand it to everyone (we seriously can’t afford that).

I think a better course would be to replace the current set of deductions with a credit, which would be worth the same to everyone, despite their incomes and interest deductions. Even better, restrict it to new home buyers only!

Unfortunately, Tim, this just wouldn’t pass. It amounts to a progressive tax increase, and congress is willing to SHUT DOWN THE GOVERNMENT rather than allow ANY tax increase, much less a progressive tax increase.

Personally I’d be fine with this. And I just bought a home, and financed a good deal of it. I’d be willing to take a hit for a progressive tax increase, as long as it went toward reducing the deficit (and therefore keep Washington from gutting SS and Medicare.)

Have you figured out what the deduction would be if you did this, and made it deficit neutral? That would be an interesting exercise.

David S, you’re in the second highest tax bracket? Cry me a freaking river. I’m in pretty much the same situation, and I thank God every day for being so fortunate.

Also you’re actually being taxed somewhere between 22% and 27% of your total income, not 33%.

I’m afraid I must play the role of curmudgeon. How about we lobby for the government to abandon reckless social engineering experiments and stay the heck out of the housing market all together?

I agree completely. I’m just trying to be a little realistic here. It seems to me that there is zero chance of the government getting out of the business of boosting real estate. There’s a very small, but presumably non-zero chance that they might be willing to adjust their involvement in some way that makes more sense than today’s mess.

If I’m interpreting this page correctly: http://www.irs.gov/publications/p17/ch22.html it sounds like you can already deduct anything you pay in property taxes from your taxable income. So, it sounds to me like there already is an incentive to be a homeowner, as this adds another deduction that is not available to non-homeowners.

We subsidize others’ personal expenses all the time, it’s all a matter of perspective. I subsidize people’s kids and their schools. Telecommuters subsidize the roads I take to work. I subsidize any number of wars that I’m vociferously against. I subsidize the elderly’s medical expenses, and the pensions of soldiers.

Some of this I’m glad to pay, some of it rankles. Some of it I’ll benefit from in the future. Subsidizing others (and being subsidized in return) is pretty ubiquitous.

The only one that particularly gets my goat is paying an essentially flat rate for water and sewage when my wife and I use something like a third of that of the average household. ;-)

Have you noticed in today’s IRS mess, we spend a lion’s share of the time blogging to each other on the IRS rules? Hades, call ’em, it TOTALLY confuses the IRS too.

How about this solution, we replace the current convoluted income tax mess and its circus parade of deduction clowns [mostly going to the rich BTW], with a 10% federal sales tax. No one’s immune [even GE that paid no income tax] and if ya sell a house, Uncle Sam get’s 10% at closing, same with a new car. Corporations like Boeing and MSFT buy material and supplies, they pay a 10% sales tax. If the corporations off shore for materials/assemblies and it enters America [in the foreign product sales item or assembled in America in a domestic end item product], they pay the sales tax. That way, foreign end items [like cars or anything else for that matter] DIRECTLY reduce our tax deficit as Americans purchase them [and if ya buy foreign, the buyer pays the sales tax again, if its assembled in America only part of it is double sales taxed]. Domestic cars and end items will only be taxed once, good gosh, they produce a tax base churning on their own, FAR greater than foreign stuff.

Take the federal tax off food and rent to protect the poor [the poor are the bottom 90% of American household incomes paying most, or at least a lion’s share, of their income on food and rent].

Mortgage payments and interest would not be taxed either.

The laid off IRS income tax workers can be re-hired to audit corporations and rich for proper books on sales tax revenue to the federal government. We’ll still need ’em.

Given how many billions and trillions our government has given the financial services industry in the last few years, it’s pretty obvious that they are a top buyer of politicians as well. Presumably they prefer the mortgage interest deduction.

Why as a homeowner should I subsidize an apartment owner’s mortgage expenses thereby lowering his (or her) expense margin so that dirty renters get lower rent? ;) I demand that the deductibility of interest payments made on business property (ie apartments, triplexes, rental homes) be abolished. Landlords/property owners can deduct the amount paid in interest on a mortgage against the income of the property.
(Source: http://www.irs.gov/publications/p535/ch04.html#en_US_2010_publink1000243104)
Why should dirty renters (;)) pay lower rent when if this deduction were taken away it would increase the expenses to most landlords which as we know always gets passed on the renter? If mortgage interest deductions were abolished on primary residences wouldn’t it stand to reason that business/landlord mortgage interest deductibility should go away too? Homeowners aren’t the only beneficiaries of tax breaks targeted at mortgage interest.

In all seriousness though I agree with Scotsman we need to get out of the system of picking winners and losers and reform and simplify the tax code. Eliminate loopholes, close down most (but not all) tax deductions and lower the tax rate. Doing so would actually boost revenue and drastically help reduce the deficit. After looking at our 2010 taxes my wife and I are in the 25% tax bracket but after tax credits and deductions our effective tax burden was only 5.34% this last year. I looked it up to verify. Something needs to change.

In all seriousness though I agree with Scotsman we need to get out of the system of picking winners and losers and reform and simplify the tax code. Eliminate loopholes, close down most (but not all) tax deductions and lower the tax rate.

Hey, deep-pocketed corporations and interest groups bought those loopholes fair and square. What are you, some kind of communist?

Getting others to do something through tax incentives is a lot cheaper and more efficient than government doing that same something. So I don’t have a problem with tax incentives. The question is what type of activity should provide for incentives.

The Tim- Yeap that’s me, a Communist. I thought free market types simple and consistent regulation. Its the most stable environment for the invisible hand of the market to work right? Someone needs to tell corporations that if they kill the host, the parasite dies too. Now I really sound like a Communist. Hail Marx.

Kary- In theory I agree but practice has told us more often than not tax incentives are bought, twisted, and molded into something different than they were created for. In the end it benefits those are willing to pay for them in Congress, not incentivizing things that would make the country stronger, more productive and prosperous for all (or even most). Wow I totally sound like a an Occupy Seattle demonstrator depending on your perspective.

It’s going to be an interesting few years in politics. There’s obviously a big groundswell of populism, but what did that engender in the last election? The election of the most transparent corporate tools in history. Just look at what Rick Scott’s doing in Florida.

I’m sorry, guys. I think we’re getting the politicians we deserve at this point.

You’d Be Surprised How Small This Tax Would Need to Be Once Its Applied to Outsourced Items [currently untaxed]

The GAO could verify the actual needed number to run the government and the President could be the PR when WTO [and American corporations paying little or no taxes] sues America for protectionism. He might want to wear a bullet proof vest.

You stated: “We subsidize others’ personal expenses all the time, it’s all a matter of perspective. I subsidize people’s kids and their schools. Telecommuters subsidize the roads I take to work. I subsidize any number of wars that I’m vociferously against. I subsidize the elderly’s medical expenses, and the pensions of soldiers.”

Let’s define “person expenses”. Schools, roads, fire department, police, etc are for the good of the community, and should you want to use them they are available to use. I have never had the fire department to my home, yet I am happy to pay taxes to support them, as should I want to use their services, they would be available to me to use. I have not used the library for years – but again, I do not mind paying taxes to support it, as contributes to the common good and I could use it if I wanted to.

However – the guy with the beautiful home with granite counter tops – who I am subsidizing the cost of through mortgage interest deduction – does not allow the taxpayer (me) to stop over and use his home should I want to. It is for his private use, and therefore his “personal expenses”.

If I’m interpreting this page correctly: http://www.irs.gov/publications/p17/ch22.html it sounds like you can already deduct anything you pay in property taxes from your taxable income. So, it sounds to me like there already is an incentive to be a homeowner, as this adds another deduction that is not available to non-homeowners.

DaveO,

Dry your eyes. If you pay my property taxes, you can have my deduction.

So, basically, like every liberal I’ve ever met, you all are advocating that everyone should be brought down to the level of the lowest common denominator. In case you all missed the news in the past 20 yrs, socialism/communism failed.

Additionally, you all talk about subsidizing us “rich” folk with mortgages. Well, everytime I write a check to pay my property taxes, I’m subsidizing the education of one of your snot nosed, apartment dwelling, punk kids. I am so sick and tired of hearing from people that begrudge what my wife and I have busted our butts to achieve because they don’t have it. Get over it!

Maybe if you busted your butts for the past 35 yrs instead of waiting around for someone to hand you something on a silver platter, you might better appreciate what others have been able to accomplish and not be so quick to want to whine about what they have and you don’t!

RE:rem @ 52 –
It shouldn’t take three posts for you to b*tch about how rough you have it being rich, and how discriminated against you feel simply by attaining wealth.
I’ve got no problem with you having worked hard and having earned lots of money.
What I have a problem with is this:
If you’ve made a million bucks a year and are in the 35% tax bracket, you feel that you are entitled to deduct your mortgage interest, that the government is supposed to subsidize you to the tune of many thousands of dollars per year, while a homeowner with a modest home and salary doesn’t even make enough money to itemize deductions, or if they do it’s at the 10% rate. That’s called socialism for the rich. ” I made a lot of money, so I need my version of welfare” doesn’t cut it with me. Go ahead, call me a liberal, communist, socialist radical, whatever, but I just don’t think you deserve this huge mortgage interest deduction, far higher than anybody else gets, simply because you made a lot of money. The government gets it’s revenues from taxes, whether they be property taxes or income taxes, and right now we likely need a combination of reducing expenditures and increasing revenues. How do you propose doing this? Should we close all public schools so we don’t have to educate those unwashed masses? Close libraries? Parks? Shut down all public transit?
Or should we make your taxes even lower, because you have attained godlike status by getting rich? Maybe us peons could pay for your next sports arena.

RE:Ira Sacharoff @ 53 – Isn’t someone who makes $1,000,000 a year severely restricted on what they can deduct in home interest?

Also, the real socialism is that standard deduction. ;-)

Depends on the price of the home. If I recall, you can deduct all the interest on a one million dollar home. But if you’re making a million dollars a year, a one million dollar home would probably be considered too ghetto.
…And I know y’all agree with me. You’re just surprised that mild mannered reasonable Ira went on the attack. It happens. Especially if it takes you three posts to complain about how rough rich people have it.

[…] or reducing the mortgage interest deduction has been popping up for the last couple of years. A year ago I said that it was “unlikely that any of the current talk of eliminating the mortgage interest […]